The investment haze around the Fed and its stimulus

Posted: June 18, 2013

With Wall Street's awaiting the Federal Reserve's statement after its two-day meeting concludes Wednesday, you'd think there was a Super Bowl of money at stake. And there is.

But some investors are tired of the rules of the game - they want to see the referees stop determining the score.

Investors would like to witness the Fed's purchases of bonds to come to an end, so the stock and fixed-income market distortions can stop and allow the economy to function without interference.

"The sooner QE (qualitative easing) ends, the better," says Scott Armiger, chief investment officer of Christiana Trust, a division of WSFS Bank, with more than $15 billion in assets.

The Federal Reserve's intervention in helping to revive the economy after 2008 is unprecedented, notes Mark Luschini, chief investment strategist at Janney Montgomery Scott. In addition to its historic interest rate policy, which has pushed rates down to near zero percent in 2008 and holding them there ever since, the Fed is still buying $85 billion worth of Treasury and mortgage-backed bonds every month.

Guy LeBas, Janney's fixed income strategist, says this week's hearings will set a very prolonged stage for ending Fed-sponsored QE, or quantitative easing: What we're seeing is the Fed setting up the prerequisites necessary to slow their bond-buying program. It's worth pointing out, however, that the process of slowing is in itself likely to be a very long one."

So far this year, investors have prepped themselves for rising rates and falling bond prices: $16.3 billion has flowed into fixed-income exchange-traded funds designed to have low sensitivity to interest rates, according to Bloomberg data. Some of those funds include the SPDR Blackstone/GSO Senior Loan ETF (symbol: SRLN) and PowerShares Senior Loan ETF (symbol: BKLN).

Christiana Trust's Armiger says his portfolio strategy hasn't changed much in the past year. The firm is still recommending shares of healthcare companies, consumer staples, and industrials like United Technologies (UTX), and does not own Treasuries at all for its clients. The Federal deficit looks better than it really is, due to the many investors who took capital gains before the new tax rates kicked in. In the meantime, serious discussions about trimming the budget have all but stalled, as Congress takes its habitual nap between fiscal crises.

"There's enough good paper out there, that you can do better with municipal bonds or brokerage CDs," Armiger says. His firm likes munis issued by states such as North Carolina, South Dakota, Texas, and Georgia, but not Illinois or California. He's leery of buying munis like Puerto Rico, Guam or the U.S. Virgin Islands, saying "those islands have issues."

Meanwhile, the currency devaluations around the world have him worried.

"Japan has joined us in a race to the bottom. Equity investors seeking silver linings should be careful not to conflate fair value with wishful thinking," Armiger said. "This is a risky time for rosy scenarios."

Japan's devaluation of its yen will ultimately hurt U.S. manufacturers. "We looked at some Fed districts like New York, Philadelphia and Dallas and they showed contraction in May. The cheap yen makes it more expensive for us to export," Armiger added.

And the purported mini-boom in housing may not be sustainable. Institutional buyers - rather than mom-and-pop buyers - represented a large percentage of recent sales, and the Federal Housing Authority and other major players in the mortgage market have already perceived a shift in the Fed's mortgage-backed securities purchasing policy, prompting mortgage rates to rise.

"We get the feeling there's distortion" in the mortgage market, Armiger adds. Mortgage rates are now hovering around 4 percent for a 30-year fixed rate mortgage, up from 3.5 percent in the summer of 2012.


Erin Arvedlund is a finance reporter and a resident of Philadelphia. Contact her at 646-797-0759 or erin.arvedlund@yahoo.com.

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